Posted by: The Soaring Eagle | April 19, 2011

Value-based Investment: Wonderful Businesses


 

This is the heart of our value-investing discussion. If you haven’t already, I suggest you go back and read the previous articles in this series.

A Wonderful business is one that delivers value to its customers, shareholders, and employees. The role of the management of such business is to balance those interests, yet satisfy them to a reasonable degree.

This leads us to a key element in spotting a wonderful business: Its management. Who is calling the shots? How does the management maintain a positive balance sheet? What are their pay packages? Are those in line with the financial temperature of the business? We could spend hours asking such questions. The bottom line is to investigate the managing team, meet some of them if possible, ask the tough questions. You should be satisfied with their management style and their track record, before you give them your hard-earned money.

Next, or parallel to that, you need to roll up your sleeves for few hours, or maybe days, to research the financial health of the company. The first station your research train will stop at is the annual report. Reading and understanding annual reports gives you a tremendous edge, yet it’s not easy at all. Studying the financial history of the company gives you a good idea concerning its future. The most important annual report to dig through is the last one. But you should have a look at the annual reports of at least the last five years.

Questions you may want to ask, and find solid answers to, are:

  • Have the earnings been growing quarter over quarter, during the last five years?
  • Has the compensation of employees, especially the executives, been in line with the growth of the business?
  • What is the market capitalization? Is it a small cap or a large cap, or something in between?
  • Does the business pay dividends to the shareholders? What’s the dividend percentage of the share price? Look for something above 2%
  • Are their strategies in place to reduce the cost of production without affecting the quality?
  • How much debt does the company carry from quarter to quarter?
  • What is the net Earning/share (EPS) for the last four quarters, the last five years, and maybe 10 years?
  • Has the EPS been growing or declining?
  • What is the current Price / Earning (P/E) ratio? You need that to be as low as possible. Be careful of any P/E above 20
  • Are there any legal issues facing the business?
  • How does the business compare to its competitors in terms of market share?
  • How much does the business spend on research and development? A retail chain must have a different figure here than a pharmaceutical company, provided everything else is the same
  • Simplicity is another factor. Although it’s not very easy to find out, but it’s worth the research. The more complex the business is, the more prone it is to problems down the road. The reward of simplicity is a low-maintenance business. As an intelligent Investor, you should not fall in love with the business. Even if you love technology, for example, this is not enough reason to buy technology shares, unless they prove to be wonderful businesses!

What you’re looking for is a stable business, which has been growing nicely for quite some time, and which has good, honest, and capable management. A management team that has been successful in making that business a vehicle to delivering real value.

The key words here are: Stability, sustainable growth, ethics, value, and it won’t harm to have some fun along the way!

To be continued…

The Wealth Maker

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